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Changing Economics in an Era of Healthcare Reform

By Nate Kaufman, April 2, 2012

Health systems are beginning to prepare for healthcare reform.  Significant resources are being focused on developing Accountable Care Organizations, medical homes, and preparing for bundled payments and population-based reimbursement.  However, current economic trends combined with an analysis of the impact of key healthcare reform initiatives, will require health systems to take significant cost out of their system in order to maintain positive financial performance. Few organizations have the culture or the expertise to implement a cost reduction effort of this magnitude.

These are the Good 'Ol' Days (For Cost Shifting)

Since the late 80’s the hospital industry has subsidized losses from Medicare and Medicaid by demanding premium rates from commercial payers. In 2008, the hospital industry’s aggregate payment to cost ratio from Medicare was 90.9% ;  88.7% from Medicaid and 128.3% from commercial payers.[1] The impact of cost shifting will be diminished as a result of the new healthcare reform law, the aging of the population, continued compression of government/ private reimbursement and increased patient responsibility.  This will require most health systems to reduce their current operating cost structure by 10-15%. The following is a discussion of the key factors driving the need for more focus on efficiency.

Change in Payer Mix

Over the next five years there will be a significant shift in the number of people covered by highly profitable private health plans to deficit-generating government-sponsored plans.  Expanded coverage for the uninsured will not be sufficient to mitigate the negative impact of this shift.  CMS estimates that by 2016, as a result of the new healthcare reform act (PPACA) and the aging of the population, the number of beneficiaries covered by the relatively high margin private insurance will decline by approximately 9 million.  These profitable patients will be lost to government-sponsored plans with non-negotiable provider rates (i.e., Medicare, Medicaid and exchanges.) The financial benefit of providing coverage for the 25.3 million uninsured, most of whom will receive government-funded insurance, will not be sufficient to offset the deleterious effects of the shift away from commercial health plans[2]

Declining Medicare and Medicaid Margins

Future payment increases from Medicare and Medicaid will not keep pace with the historical trend in hospital cost inflation. This will further suppress the margin contribution from government-funded reimbursement making the cost shifting hurdle for private insurance even higher than in the past.  In their 2010 Report to Congress, Medpac acknowledged that since 1996, hospitals margins from Medicare have declined by approximately 1 percent per year.[3]  Their data shows that the average hospital lost 7.2 cents on every dollar of care provided to Medicare patients in 2008. (Note: the Medpac methodology is different from AHA.)  Even before the $155 Billion hospital payment reduction in PPACA, Medpac expressed its intention to force hospitals to operate more efficiently by continuing to provide updates to hospitals at rates that are significantly below cost inflation. Medpac believes that it is possible to provide quality care and breakeven on Medicare:

Medicare margins are low and expected to remain negative… however...a set of hospitals has been able to maintain relatively low costs, while maintaining relatively high quality of care. Roughly half of these providers are [currently] generating a profit on their Medicare business.[4]     

With respect to Medicaid, the Kaiser Family Foundation reports that for FY 2010, a total of 33 states restricted hospital payment rates including 14 states that froze rates and 19 states that reduced rates. For FY 2011, 17 states plan hospital rate freezes and 13 states plan hospital cuts for a total of 37 planned rate restrictions.[5]

Increased Patient Responsibility Will the Limit the Ability to Cost Shift

As patients are forced to pay a greater percentage of their healthcare costs, higher provider charges will result in increased bad debt and lower utilization rather than increased income.  The fastest growing component of bad debt in hospitals is unpaid co-payments and deductibles from patients with insurance.[6]  One health system studied by McKinsey reported that their unpaid balance for patients with insurance was growing by 30% per year, much faster than bad debt from patients without insurance.

 Enrollment in high deductible employer-sponsored health plans climbed from 9% in 2009 to 11% in 2010. Low-income families with high deductibles are more likely to “delay or indefinitely postpone medical procedures.”[7] The increase in patient financial responsibility combined with the poor economy have contributed to the year over year decline in physician visits[8]  and  an unprecedented decline in admissions to not-for-profit hospitals.[9]

Increased Regulatory Oversight on Private Health Plans Will Create Downward Pressure on Provider Rates

The healthcare reform environment has not been kind to the private insurance companies. A number of states have laws or are preparing legislation to enable their insurance commissioners to block or reduce proposed premium increases.  In addition, PPACA gives the HHS Secretary the authority to regulate excessive rate increases.  Last year in Massachusetts, when proposed rates of increase in private insurance premiums were rejected by the Department of Insurance, the insurance companies proposed freezing or reducing payments to hospitals and large physician groups.[10]

The Cost of Physician Integration

The mad dash towards the development of ACOs will only exacerbate the cost issues in most health systems. The infrastructure costs associated with forming and operating a high-functioning ACO are significant and return on this investment is uncertain at best. The law stipulates that ACO’s will be rewarded for improving quality and reducing cost. The majority of these cost reductions will come from reductions in the volume of specialty consultations, high-end procedures and hospital admission.  There is no evidence that the health system’s “shared savings” payments from its ACO efforts will offset the infrastructure costs, the loss in volume, revenue or the political capital being invested in this effort. 

If You Keep Doing the Same Thing, Don’t Expect Different Results

Many health systems continue to operate as though cost-shifting will remain a viable strategy in the long term. Their primary focus is fiddling with ACOs as their organizations begin to bend under the stress of flat to declining revenues.  A new radically-intense focus on the cost of care is essential if a health system is going to succeed in the future.  Getting in shape for 2016 will require the following:

  1. Define the efficiency targets for the organization and stick to them. Leadership is critical for setting the course for the organization.
  2. Engage the physicians and hospital staff in discussions about the need to significantly reduce the cost of care in the organization.
  3. Hold all members of the organization (including medical directors) accountable for:

    1. non-negotiable, performance based, cost budgets based on industry best practices and
    2. attracting profitable growth in their service lines
  4. Develop a plan to reduce the cost structure of the organization to breakeven on Medicare rates. Note: Private payers will continue to pay at rates above Medicare but the ability to absorb declining Medicare margins through cost shifting will be limited.
  5. Rationalize your portfolio of services and facilities, eliminating duplication and divesting of services that generate deficits  the organization can no longer afford to absorb.
  6. Workforce reductions will not generate sufficient savings. Employ established redesign methods e.g., LEAN to eliminate waste and unnecessary variability of care.
  7. Use objective critical analyses to ensure optimal performance of IT, revenue cycle, supply chain and clinical documentation systems. This usually requires an audit by an independent third party
  8. Using physician leaders,  create a culture within the employed physician group that is aligned with the objectives of the health system.
  9. Begin a process of true clinical integration with your physicians focusing on the basics of  redesigning the delivery of care, but don’t try to be an ACO by 2012. Most health systems will not be ready by 2012.  The only thing worse than not having an ACO, is operating an ACO that fails to achieve desired results.  Eventually  every health system will be held accountable for their cost and quality, either on a per episode or per capita basis but most current models of clinical integration involving retrospective review will not be sufficient.  Becoming an effective clinically integrated organization will take time, discipline and ultimately a cultural change among members of the medical staff. Critical success criteria for  clinically integrated  delivery systems must include the following:

    1. Physicians in critical specialties must participate and be willing to standardize their clinical practices based on the best science in medicine.
    2. All providers must be able to share an EHR that includes hardwired point of care protocols.
    3. There needs to be sufficient primary care capacity using extenders as the first line of care.
    4. Engaged physician champions must drive the process.
    5. There should be a programmatic approach to chronic diseases such as diabetes, CHF etc.
    6. Hospitalists, intensivists and other key physicians in the care process must be trained in the latest care delivery techniques and be evaluated based on cost, quality and service metrics.
    7. Physicians that do not meet key cost and quality metrics must be sanctioned.
    8. There must be an infrastructure able to manage the delivery system, monitor metrics and report outcomes.

The healthcare delivery system will not change overnight. Organizations that begin repositioning today can phase in the cost reduction strategies necessary to succeed under the post-reform environment.  Transforming a health system will be expensive.  Healthcare leaders will need to optimize income in the fee for service delivery system in order to fund long term investments in their physicians, IT systems, process redesign, clinical integration, etc. The irony is that the primary source of the dollars to fund this transformation will come from cost shifting... get it while it lasts.

[1] AHA; Trend Watch Chartbook 2010, Table 4.4

[2] Center for Medicare Services (CMS);  Richard Foster Memo | Apr 22, 2010, Table 2

[3] Medpac; Report to Congress: Medicare Payment Policy| Mar 2010; Hospital Inpatient and Outpatient Services, Assessment of Payment Adequacy, Updating Payments,  pp 41-66

[4] Medpac; Report to Congress: Medicare Payment Policy| March 2010; Hospital Inpatient and Outpatient Services, Assessment of Payment Adequacy, Updating Payments,  pp 60

[5] Commission on Medicaid and the Kaiser Family Foundation;  A Look at Medicaid Pending Coverage and Policy Tends Results for a 50-State Medicaid Budget Survey for State Fiscal Years 2010 and 2011; Prepared by Vernon K. Smith, Ph.D., Kathleen Gifford and Eileen Ellis, Health Management Associates; Robin Rudowitz and Laura Kaiser,  | Sep 2010

[6] Mckinsey Quarterly; The Next Wave of Change for us in Healthcare Payments| May 2010,  page 2

[7] Reuters; Cost-Sharing Health Plans Lead Poor to Make More Tough Choices | Nov 23, 2010

[8]; American Medical News | Sep 20, 2010

[9] Moody’s; Flat Admissions Put Pressure on Not-for-Profit Hospitals | Oct 20, 2010

[10] Boston Globe, Insurers May Slash Rates to Hospitals | May24, 2010

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